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Commercial Real Estate forecasts are always interesting to me, especially when presented by someone not selling a product or service. At the East Bay CREW meeting, 2010 President Tillie Ross of Old Republic Title introduced her guest speaker, Brian Pretti, CFA, CFP and senior Vice President of Mechanics Bank. The following is a summary of my notes and the handout provided by Brian.

One of the key macro issues the private sector is experiencing net debt contraction, otherwise known as deleveraging. Consumers are paying off loans and starting to save. This is the first time in decades that people are not borrowing and is the main argument for why this recession/recovery is different than any post World War 2 economic cycle. Of course, we all know the government is borrowing and spending without fear- for now it is the best course of action. “The government MUST continue to borrow and spend until the private sector recovers/deleverages” says Brian. Another newsworthy item to watch will be politics. Politicians will need to provide a job stimulus to include a small business stimulus. Brian predicts politicians will turn against Wall Street if necessary, in an effort to jump start a stimulus.

OK, let’s say we get a stimulus- however Washington and Wall Street make it happen. What about interest rates? Interest Rates are still at the lowest point in a generation, yet there is little borrowing by consumers. This is probably because there is no economic confidence, high unemployment numbers don’t help and there is no pent up demand for goods and services. Brian pointed out that these factors along with the fact that this “reconciliation cycle” can take time indicates that this recovery will take years. In a nutshell, we over-borrowed and we are now paying down our debt. That’s good individually, but it is not an economic stimulating activity.

As China slows their purchase of US bonds, the Treasury department is printing dollars to buy back our own bonds. Brian calls this a “Balance Sheet Recession” and this takes time (years) to heal. Until the private sector picks up, the government cannot stop borrowing and spending. An unintended consequence of such actions is the degradation of the value of the dollar and of course commercial real estate in general. Another unintended consequence is the degradation of pension fund values. Pension funds own commercial real estate as a vehicle to pay their liabilities. What will happen when pension demands exceed available cash flows?

Another reason this recession/recovery is different than others; foreign countries own 55% of US debt. This makes the challenge global not just national. Additionally, the government has refused to allow an audit of itself! What else is hidden from public view?

Brian predicts we may see a government sponsored recovery by Q3 2010. All eyes should be on the private sector. To allow debt pay down, the government must keep Gross Domestic Product (GDP) positive - this has never been done before. Until the private sector is comfortable borrowing again, this “Balance Sheet Deleveraging” will continue to be a drag on the economy. In the short term, the critical issues for investors and businesses are the unintended consequences of government borrowing and spending.

Concluding thoughts:

The private sector credit contraction is very different and is not part of a typical economic cycle. Commercial Real Estate is ground zero. We have overbuilt and now have an oversupply. Energy costs are rising and as such, businesses that cut expenses will thrive. Older buildings become less valuable. Untold hidden commercial real estate problems discourage banks from lending. Brian points out that consumers “appear to be in the midst of profound behavioral change- they are not borrowing or spending”. Thus, US boomer and industrialized economy demographics are a critical consideration in business and investing decisions. This economic cycle demands new thinking because we have never seen this before. Thank you to Brian Pretti of Mechanic’s Bank for this presentation.

If you or someone you know is looking to sell or buy apartments or commercial real estate or just one commercial property OR if there is a consideration to learn more about group investments in commercial real estate please contact me. I can be reached via email at Pete@CommercialMasterMinds.com or just call (925) 719-3569

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Continued Success, Pete